WV 2ag I o
POLICY RESEARCH WORKING PAPER 2910
Boondoggles and Expropriation
Rent-seeking and Policy Distortion
when Property Rights are Insecure
Philip Keefer
Stephen Knack
The World Bank F
Development Research Group L 3
Investment Climate Team
and
Public Services Team
October 2002
I POLICY RESEARCH WORKING PAPER 2910
Abstract
Most analyses of property rights and economic They may reduce the incentives of governments to
development point to the negative influence of insecure use tax revenues for productive purposes, such as public
property rights on private investment. Keefer and Knack investment.
focus instead on the largely unexamined effects of - They do so whether one regards the principal
insecure property rights on government policy choices. problem of insecure property rights as the maintenance
They identify one significant anomaly-dramatically of law and order, which government spending can
higher public investment in countries with insecure potentially remedy, or as the threat of expropriation by
property rights-and use it to make the following broad government itself, and therefore not remediable by
claims about insecure property rights: government spending.
They increase rent-seeking. The authors present substantial empirical evidence to
support these claims.
This paper-a product of the Investment Climate and Public Services Teams, Development Research Group-is part of a
larger effort in the group to investigate the institutional roots of effective government policy. Copies of the paper are
available free from the World Bank, 1818 H Street NW, Washington, DC 20433. Please contact Paulina Sintim-Aboagye,
room MC3-422, telephone 202-473-8526, fax 202-522-1155, email address psintimaboagye@worldbank.org. Policy
Research Working Papers are also posted on the Web at http://econ.worldbank.org. The authors may be contacted at
pkeefer@worldbank.org or sknack@worldbank.org. October 2002. (30 pages)
The Policy Research Working Paper Senes disseminates the findings of work in progress to encourage the exchange of ideas about
development issues. An objective of the series is to get the findings out quickly, even if the presentations are less than fully polished. The
papers carry the names of the authors and should be cited accordingly. The findings, interpretations, and conclusions expressed in this
paper are entirely those of the authors. They do not necessarily represent the view of the World Bank, its Executive Directors, or the
countries they represent.
Produced by the Research Advisory Staff
Boondoggles and expropriation:
Rent-seeking and policy distortion when property rights are
insecure
Philip Keefer Stephen Knack
The World Bank The World Bank
pkeefer&worldbank.org sknack@worldbank.org
Boondoggles and expropriation:
Rent-seeking and policy distortion when property rights are insecure'
The security of property rights has a well-known and significant role in economic
development. In explaining the links between the two, most analyses point to the direct
effect that insecure property rights have on private investment. This focus does not explain
significant anomalies in government policy making between countries with secure and
insecure property rights. This paper uses one such anomaly, the fact that the ratio of public
investment either to national income or to private investment is dramatically higher in
countries with insecure property rights than other countries, to make the following broad
claims: insecure property rights increase rent-seeking by government; they may reduce the
incentives of governments to use tax revenues for productive purposes; and, finally, these
effects emerge regardless of whether one regards the principal problem of insecure property
rights as the maintenance of law and order among citizens, which government spending can
potentially remedy, or as the threat of expropriation by government itself, and therefore not
remediable by government spending. Empirical tests reported in the second half of this
paper provide evidence for each of these claims.
On the other hand, our analytical results reject the argument that governments have
an incentive to increase public investment when property rights insecurity drives down
private investment. On the contrary, as long as public investment is complementary to
private investment, the opposite is true. However, when one allows rent-seeking and public
investrnent decisions to interact, the analytical results generate predictions that are consistent
with the empirical record reported in the second half of the paper: observed public
spending rises with the insecurity of property rights.
With respect specifically to public investment, the analysis provides an explanation
for the ambiguous and often negligible growth effects that have been found for public
investment in the literature. The analysis here suggests that the effects of observed public
investment on growth are likely to vary with the security of property rights. However, the
interaction between the security of property rights and public investment has not been
considered in this large literature. The tests reported at the end of this paper support the
notion that public investment can have a positive effect on growth, but that this effect is
I We are grateful to Karla Hoff, Martin NMeurers and Paul Zak for thorough and very helpful comments.
revealed only when one accounts for the differing incentives of governments, under
different property rights environments, to use public investment for rent-seeking purposes.
Public investment and growth
The analysis in this paper begins with Barro's (1990) canonical analysis of public
investment and growth. In the sections following, we expand on the conception of property
rights that Barro hints at in his model and contrast it to a more institutional approach to
property rights that is common in the literature. In the final stage of the analysis we
introduce the potential for government rent-seeking, from which we derive our testable
predictions.
Barro (1990) begins with a representative, infinite-lived household in a closed
economy, maximizing utility given by U = f u(c)e-Odt, where c is consumption per
person, p>O is the constant discount rate and u(c) = a , where a > 0. Production
per capita in the model is given byy=kO = Ak(k k) . A flat income tax finances public
good spending, so the marginal private return to private investment is
(1- r) = (I r(Xl - a){ k ) The growth rate of consumption is therefore
(1) yV =-[(I - rl -a)A _k ) -P].
Both benevolent and rent-seeking governments maximize (1) with respect tog/y to
find the rate of public investment that maximizes growth. Rent-seeking governments then
go on to maximize their utility with respect to rents, the amount of taxes they collect above
and beyond the amount needed to fund growth-maximizing public investment. Assuming
that all tax revenues are spent on public investment (r = gly) and that the production
function is Cobb-Douglass, and noting that (g / k) = (g / y) - q(g / k), differentiation gives
Barro's equation (15):
(2) dr(g (O'-l).
d(Got k
Growth is miaximlized when the expression in (2) is equal to zero, yielding?z a. Barro
3
argues that since all governments would setg/k such that growth is maximized, there should
be no observed correlation between public investment and growth. Rates of public
investment should only vary across countries because of variations in the relative
productivity of private and public capital which are not themselves correlated with growth.
The effect of property rights on public investment and growth
There are at least two ways to introduce the security of property rights into the
model above. One approach is suggested in Barro's (1990) public investment work and is
common in the growth literature (e.g., Barro, Mankiw and Sala-i-Martin 1995, or Belletini
and Ceroni). In this literature, property rights insecurity is a tax, implying that property
rights security can be modified by government with the same facility that it modifies taxes
more generally. Barro (1990) specifically assumes that governments can spend resources to
curb attempts by some households to steal the output of other households: "An increase in
spending, g, in areas that enhance property rights causes a reduction in the effective value of
rrather than a direct effect on the production function... .[t]he relation of growth and saving
rates to the amount of government expenditure devoted to the enforcement of property
rights would resemble [those of other productive government expenditures]." (Barro 1990,
p. S116).2 Although public spending consequences are implied by this "fiscal" model of
property rights, they have not been formally modeled nor tested.
An alternative approach to property rights is taken in the more institutionally-
oriented literature. In this literature, the problem is not one of "law and order", where
households fear expropriation by other private parties, but rather one of the ability of the
state to credibly commit not to expropriate sunk investments. North and Weingast (1989),
Acemoglu and Robinson (2001), Clague et al. (1996), Keefer and Stasavage (2000) and many
others emphasize the institutional roots of insecure property rights, particularly the ability of
governments to commit credibly not to expropriate privately-held assets. Institutions are
not easily susceptible to change by government officials. As with the fiscal model of
property rights, the institutional model has not been formally integrated into a dynamic
2 Zak (2000) also models the property rights problem as one of expropriation by some households of others,
and allows government to expend resources on policing to reduce this risk. Unlike Barro (1990), he
endogenizes the expropriation risk that households impose on each other, however, his model abstracts from
the decision by government to invest in public infrastructure.
4
model of government fiscal decision making in a growth context.3
The two approaches embrace two distinct problems. The fiscal approach to
property rights focuses on the law and order threat that citizens pose to each other, and the
costs to government of dealing with that threat. It does not explicitly ask what conditions
make these costs higher in some countries than others. The institutional model focuses on
the threat of government expropriation and directly suggests institutional sources of
variations in the severity of this threat across countries. Most of the cross-country evidence
that sheds light on the impact of property rights is most easily interpreted in the context of
the second model including the evidence presented below.
One might imagine that governments would have an incentive to offset reduced
private investment due to insecure property rights with greater public investment. Under
either approach to property rights, the theoretical analysis below shows that governments do
not have an incentive to do this, as long as public investment is a complement to private
investrnent, as assumed in all of the public investment literature, rather than a substitute for
it. An additional consideration, besides the insecurity of property rights in and of itself, is
necessary to explain our empirical findings that public investment is highest in countries with
the weakest property rights.
Property rights as a fiscal problem
If property rights security were easily influenced by government budget decisions,
then the decision to spend resources to improve the security of property rights would be
directly linked to the decision to spend resources on public investment. To explicitly model
this, we assume that households confront a new tax rate given by THH = rp, + rPR + Kpr ),
comprised of the taxes they pay to finance public investment (rpz and more secure property
rights (rp,), and of the irnplicit tax they confront, represented by iK(-Q), which is the residual
risk to property rights after government has spent resources (e.g., on courts and police) to
mitigate that risk, dK/d-rpR < 0. The burden of insecure property rights can then be described
as (K + rpR ), the amount.that households pay to secure property rights, and the insecurity
3 A third approach views the security of property rights as neither a fiscal nor an institutional problem, but
rather a "pre-institutional" problem of struggle over resources and of investment by all actors in resources that
can be used either to defend their own assets or to expropriate the assets of others (see, e.g., Skaperdas 1995
and Sonin 2002). The government provision of property rights in these models is, however, as in the
macroeconomics literature, a simple policy decision flowing from the identity of the median voter rather than a
consequence of institutional features of the state.
5
that remains after taxes have been converted into police and courts.
As usual, households choose a consumption path that mnaximizes utility, taking as
given government policy, so that growth is given by
(3) y = - T[( HH X( - a)A(k) -]
Government then chooses r,f and rpR to maximize growth. Noting that
rp, = g/y =A-1 (g/k)l-1, substituting forg/k , and differentiating (3) with respect first to TP,
and then to TPR to get the marginal growth impacts of each, yields the two first order
1 a I
conditions given by (4) (after dividing out -_ra A l-a from each of the two conditions).
Pi
(4.1) K' =-1
(4.2) rp, = a(l -,rpR - K(rpR
Note that when property rights are irrelevant, equation (4.1) disappears and equation (4.2)
converges to the previous solution for public investment, rp, = a.
From these conditions, one can deduce immediately that more insecure property
rights reduces the incentives of governments to make productive public investments. The
ratios of productive public investment to national income and to private investment are
lower in countries with insecure property rights. From equation (4.2), the greater is the
burden of insecure property rights (K + rp, ) (spending to secure property rights and the
residual insecurity of property rights), the lower is rp,, which is simply the ratio of public
investment to national income. With respect to the ratio of public to private investment,
recall that = (A rp, )I. Substituting from equation (4.2), and differentiating both sides
k
with respect to (K + rp ), the net burden imposed by insecure property rights on households,
it follows immediately that the predicted ratio of public to private capital also drops as
property rights insecurity increases.4
The law and order approach to property rights does not predict, however, that the
security of property rights influences the growth effect of productive public investment. At
the growth-maxiniizing level of public investrnent, additional public investmrent has zero
4 Note that restricting attention to (4.2) is possible because the growth-maxkriizing level of expenditures on
6
marginal impact on growth, regardless of the secutity of property rights.5
An institutional approach to property rights and public investment
The institutional approach to property rights focuses on the threat of government
expropriation, a threat which is unlikely to be solved by increasing expenditures on courts
and police. Two of the significant explanations for variations in this threat across countries
are checks on government discretion and the time horizon of government officials. North
and Weingast and Keefer and Stasavage (2000) argue that the ability of any government to
credibly promise not to renege on its policy commmitments (e.g., not to expropriate) is
enhanced by the presence of institutional checks and balances or multiple veto players inside
government. These institutional features are at the constitutional core of the state. Similarly,
countries that have elections, which offer a sanction for decision makers who violate
promises, can also strengthen the institutional underpinnings of secure property rights.
Others (e.g., Clague et al. 1996) argue that the time horizon of leaders is another
significant determinant of their decision to expropriate. Clague, et al. (1996) that the longer
a dictator expects to survive in office, or the longer a democracy has been established, the
more secure are property rights. Leaders with long time horizons are reluctant to engage in
expropriatory actions, since the reduced investment that results hurts their ability to extract
rents in the future. Leaders with short time horizons naturally care less about future rents.
Regime horizons, though influenced by the actions of government officials while in office,
have a substantial exogenous component that is beyond the influence of government policy
instruments.
To embed these characteristics in the Barro (1990) model we first allow for the
possibility that at some point, government decision makers realize that they have only one
period left in office, that at the end of the period they must leave office, removing all
incentive they might have to maximize future growth and leading them instead to
expropriate as much private capital as possible. The amount that they can take in the last
period, though, depends on the overarching institutional environment in which they operate
(e.g., where checks and balances are significant, it is less likely that any individual
government actors can, in their last periods, extract significant rents).
property rights protection establshed in (4.1) depends only on K.
S Differentiating (3) with respect to rpi, and differentiating again with respect to (K + init), and evaluating the
result at the growth maximnzing level of public investment given by (4.2) reveals no effect of propert rights
7
Assume that neither households nor government know in which period all
government veto players will have to leave office, and that the exogenous probability that
the government will have to leave office in any given period is given by
5) F(t = 1 - e*. 6
This distribution function has the convenient property that the probability that the
government will have to leave office at some time t, conditional on not having had to leave
office earlier, is given by F'(4/(1- F()) = h, where h is invariant over time. Upon leaving
office, governments can take a share 8 of the capital that households have invested, above
and beyond whatever tax rate the government had previously established. The key here is
simply that governments can neither control nor predict the events that would make
expropriation an optimal strategy. However, they can control taxes and spending
conditional on the probability of the events occurring and the maximum rents that they can
extract should they be forced to leave office.
The specific assumptions - that the government leaves office, for example - are not
meant to capture the entire set of circumstances under which governments might
expropriate. The key assumption is simply that at some point in a government's tenure, its
incentives change unexpectedly, leading it to shift tax policy in a way that is adverse to
existing investors. The particular specification accomplishes this, although others would, as
well.
Institutions affect both F and 0. For example, in countries with strong, long-lived
political parties, the likelihood that a party will have to leave office, never to return, is lower,
reducing F and therefore b. In countries with regular elections and institutional checks and
balances, it is more difficult for political actors to expropriate in the event that they are
forced to leave office (or, more generally, in the event that their political incentives change).
Such institutions effectively lower 0.
Households maximize U = f u(c)e-Pdt, where
6.1) U = f u[(1 - F(t))(t) + F'(tXl - O)k(t)k-dt, subject to
security on the relationship between public investment and econornic growth.
6 Kamien and Schwartz (1978) introduced this expression as the probability that a research program would bear
fruit by some period t. The analogy to research and development is not strained, since R&D, like government
tenure, is affected by factors both exogenous to and within the control of key actors.
8
6.2) k=(1-r)AkI-aga-c, c20.
Equation (6.1) assumes that households consume c(t until government expropriates, at
which point they live off of their remaining capital, (1 - O)k.7 The maximization problem
can be approached by using (6.2) to rewrite (6.1) in terms of k and dk/dt. If the integrand
of (6.1) is G, the solution to the problem is then given by the Euler equation, dGdt = Gk,
or
- u [1- F(t)]+ u'F'(t) + u'p[1- F(t)] = uf(1- F(t)Xl - rX1- a)A(g) + F(t)(l -9)]
Recalling that u'=r' and u'=-arc- and rearranging terms yields the following expression for
growth
C= a [( rXI - a)A( k )-hp
As expected, growth falls as the security of property rights deteriorates.
Once again, all governments, whether rent-seeking or not, attempt to choose the
level of public investrnent that maximizes growth. As before, substituting g =(A r)l-' into
(7) and maximizing (7) with respect to r yields:
(8) dY = I A l-a r I-a (a~ 1)=0-
dr or
The predictions of this model, incorporating an institutional approach to property
rights, are somewhat distinct from those of the fiscal model of property rights. None of the
institutional parameters appear in (7), so from (7) we can immediately deduce that the share
of public investment in national income and the ratio of public to private investment are
predicted to be invariant to the security of property rights, rather than declining with the
security of property rights, as in the fiscal model. The influence of public investment on
growth is invariant to the security of property rights, as in the previous model.
In sum, the institutional approach to property rights, unlike the fiscal approach,
7 A more accurate, but more complicated setup would allow households to carry (1 - O)k into the next period,
beginning production again under a successor government. Since utility under the successor government is a
function only of the capital that households possess when the successor government comes to power, however,
the simplification has no effect on the conclusions.
9
predicts that there is no spillover from the property rights environment to government fiscal
decision making. However, in common with the fiscal approach to property rights, the
institutional approach fails to predict the relationship between the magnitude of public
investment and property rights that is observed in the data. Rent-seeking offers a logical
avenue to explore to reconcile the property rights predictions and the empirical findings.
We turn to this in the next section.
Rent-seeking, institutions and public investment
There is a significant distinction between rent-seeking and insecure property rights,
and analytical advantages to not conflating them by, for example, defining those
governments as rent-seeking that undermine property rights. Rent-seeking is best seen as
that portion of predictable government taxes that are retained by government officials for
their own uses. Threats to property rights, on the other hand, as the foregoing arguments
suggest, are best seen as the unpredictable threat that either government or citizens will
expropriate capital - possibly for their own use (as in rent-seeking), but not necessarily.
Much public investment takes the form of rent-seeking. From pork barrel spending
in the United States to white elephant steel factories in Nigeria, public investment has been
seen to serve purposes other than maximization of growth, ranging from securing political
support to securing personal fortunes. Among countless stories that show the extent to
which rent-seeking is embedded in public investment in countries with insecure property
rights is one of public investment in Turkmenistan: in a country where roads were
crumbling and water was unavailable for hours on end, the authorities an international
airport with the capacity to receive 4.5 million visitors a year, in a country that received a few
hundred thousand a year, and for which the authorities insisted on building the control
tower on the wrong side of the terminal, blocking the controllers' view of the runway.8
The public choice literature, with its emphases on rent-seeking interest groups
(Buchanan and Tullock, 1962; Olson, 1971), bureaucratic and legislative incentives
(Niskanen, 1971; Noll and Fiorina, 1978; Fenno, 1973), and the predilections of confiscatory
autocrats (Olson 1994), provide ample reasons to believe that public investment should not
be immune to the non-economic incentives of government decision makers. Pritchett
(2000) cites numerous examples of public investments with no demonstrable positive impact
8 "Palaces and Poverty in Central Asia," The Washington Post, November 11, 1994, p. A35.
10
on economic outputs at alL Tanzi and Davoodi (1997) thoroughly demonstrate an inverse
correlation between corruption and the quality of public investments across a large number
of countries.
However, the simple observation that rent-seeking is associated with public
investment is not enough to explain why public investment is higher in countries with
insecure property rights. For that, one needs to show that rent-seeking does not displace
public investment or that, if it does, rent-seeking increases at a faster rate than public
investment declines. Similarly, in the fiscal model of property rights, productive public
investment declines with property rights protection; if property rights insecurity increases
observed public investment because of higher rent-seeking, it must be the case that rent-
seeking rises faster than productive public investment falls. In both the fiscal and
institutional models of property rights, the sum of rent-seeking and productive public
investment increases as the security of property rights drops.
Barro (1990) describes a plausible way in which a rent-seeking government might
decide how much to extract from households for its own, non-public purposes. First,
government decision makers set the rate of public investrnent that naximizes growth, as in
the preceding models. Then they fix the final tax rate to maxirnize their own consumption
possibilities, conditional on the effect of this decision on future growth, holding public
investment constant. In Barro (1990), the utility of government officials in any period is
given by U(cg) = ul(r - a). y(O)e) j, where a is the growth-maximizing ratio of public
investment to income. The higher is growth, y, the more that government can consume;
higher taxes, though, suppress growth. Maximizing government utility with respect to r,
holding public investment constant, leads rent-seeking governments to set taxes such that
they can extract rents given by
(9)r a = - I a)q
The middle term in (9) simply reflects the fact that rents are higher when taxes have a
smaller effect on growth, since an increase in taxes with no offsetting increase in public
investment must have, by (1), a negative effect on growth.
When property rights are a law and order problem that can be addressed by fiscal
policy, governments can be thought of as first setting taxes and spending to protect property
rights according to (4.1), then setting taxes to set the growth-mnaximizing level of public
investment, according to (4.2), and then identifying the optimal level of rent-extraction by
maxmizing U(cg) = U[,(THH - a(l - rpR - K(rpR)) - rpR) y(O)ew ] with respect to rHH. This
yields rents given by
(10) rHH -a(l-rpR K(rpR))P rR dV
idr
where the first term in (10) corresponds to the tax rate in (9), and the remamiing terms on the
-left-hand side of (10) correspond to a in (9), such that the left-hand side of (10) is simply the
amount tax revenues that are diverted to rent-seeking rather than productivity-enhancing
activites.
From (10), and specifically the denominator of the right-hand side term, we can
deduce both that property rights insecurity exacerbates rent-seeking, and that insecure
property rights drives up rent-seeking more rapidly than it drives down productive public
investment. From the maximization of (3) and first order conditions (4.1) and (4.2), the
right-hand side of (10) can be rewritten as
(11) /T (I - a)A -rM-K(rpR ))a
By inspection, it is evident that rent-seeking increases as the security of property rights
declines (the left-hand side of (11) increases with K and -rpR). Moreover, the increase in
rent-seeking offsets the decline in productive public investment predicted by equation (4.2).
By (4.2), as property rights become more insecure (as (K + rpR ) rises), productive public
investment drops by a Differentiating the right-hand side of (11) by (K + rpR) yields
az a -a+1 a the amount by which rent-seeking increases with a decline in
(I-a) A'-a(l-r-K) l-a
the security of property rights (or, equivalently, an increase in the costliness of protecting
property rights).
For all reasonable values of the technology parameter A and the marginal utility of
consumption, a-, this expression is larger than a and the insecurity of property rights
12
increases rent-seeking (much) faster than it suppresses productive public investment.9
Intuitively, governments forego current rents if the resulting increased household investment
and faster growth promise more than offsetting increased future rents. When property
rights are insecure (or costly to secure), the promise of future rents falls for two reasons.
Directly, insecure property rights deter private investmnent; however, they also reduce private
investment indirectly, by reducing government incentives to undertake productive public
investment. The direct effect is what leads rents to increase faster than productive public
investment falls.
The addition of rent-seeking to the objectives of government turns the previous
predictions of the fiscal model of property rights on their head: as long as rent-seeking takes
the form of unproductive public investmnent, observed public investment (the sum of
productive and unproductive public investment) can rise both as a fraction of income and as
a fraction of private investment when property rights become less secure. Furthermore, the
non-productive public investnent that results from rent-seeking has a negative imnpact on
growth (or, more precisely, the taxes that finance it have a negative impact on growth).
Consequently, one would expect the effect of observed public investment on economic
growth to increase with the security of property rights, rather than exhibit no relation, as
predicted in the absence of rent-seeking.
The addition of rent-seeking to the institutional approach to property rights yields
similar conclusions. In this case, the utility function of government officials is given by (12),
where government consumes all the capital that it can expropriate, and all of the tax revenue
it retains after bringing public investment to the growth-maximizing level.
(12) U(cg) = u[(I - F(t -r --gy(O)e$ + F'(t)fc(O)ex]
Maximizing (14) with respect to r yields
(13) g _ F'(t) * 6k(O) 1
y 1- F(t) y(O) 8r/
9 This conclusion holds even if households have an outside investment option, not vulnerable to property
rights problems and not taxable by the government, as long as the rate of return on the outside option is
sufficiendy low. Obviously, if households have a very good investment option, even a slight decline in the
property rights environment would lead to a complete abandonment of the more risky productive activity, and
public investment would plummet, along widh rents. However, in most countries, most investors/households
do not have such attractive exit options.
13
The question we would like to ask is whether rents from taxation, given by.the right hand
side of (13), and rents from expropriated capital, given by the last term in (12), increase or
decrease as property rights become less secure (as 0 rises). Summing the two and
differentiating with respect to 0, yields
-h (o) + he k(0)(1-Ohl recalling = h. This expression is greater than zero -
that is, total consumption by government officials as a fraction of national income rises as
property rights become less secure - when
(14) - 1 +eh eA' (1- h9) > O.
y(o)
The right hand term of (14) is always positive and the left hand term is small. Expression
(14) indicates that over the most plausible parameter ranges, rent-seeking does, indeed,
generally rise as property rights become less secure.10 The intuition is broadly similar to that
in the fiscal model, in that as property rights become less secure, the payoffs to government
from deferring rents to the future decline. Since productive public investment, in this
model, is unaffected by the security of property rights, the net effect of insecure property
rights is to increase observed public investment as a fraction of national income and private
investment.
There are clear implications for the interpretation of public investmnent coefficients
in growth regressions. Since they are based on observed public investment, which includes
non-productive public investment created for rent-seeking purposes, the estimated growth
effects of public investment are naturally likely to be low or negative.. Failing to control for
the effects of the property rights environment on the effects of additional public investment
conflates these two sets of countries, leading to no or negative associations between public
investment and growth. Conditional on the security of property rights, however, we would
predict public investment to have a positive impact on growth. The evidence presented
below is consistent with all of these predictions.
Different institutional variables and their expected impact
In the empirical analysis that follows, we first establish the anomalies that motivate
10 If the expression in parentheses were.01, h were 99, growth were zero, and t one, the right hand side term
would be .0037. Initial period income per capita could be lower than $350 (when the left hand term would
equal -.0029), and (14) would still be positive.
14
this paper - that the ratios of public investment to national income and to private
investment are significantly higher in countdies with insecure property rights. We then
examine the implications of the foregoing analysis for economic growth, and look at the
interaction of public investment and property rights on growth. Measures of the
institutional environmnent are obviously fundamental to these tests. Unfortunately, there are
no cross-country data that allow for a specific test of the fiscal model of property rights -
the threats that citizens irnpose on each other, and the inherent differences across countries
that make these threats more cosdy to combat in some places than others. Available
variables measure a mix of both concepts. On the other hand, we are able to use two sets
of variables related to the institutional model of property rights. One set refers direcdy to
the threats posed by government action to investors. The second set captures some of the
underlying institutional factors that are argued in the institutional literature to increase the
threat of government expropriation.
Risk of expropriation and contract repudiation
Indicators of the risks of expropriation or the repudiation of contracts by
government are representative of the capacity of the government to act arbitrarily more
generally. In the work below, two indicators for these risks are employed, "Risk of
Expropriation" and "Risk of Repudiation of Contracts by Governments." These
variables are published as part of the International County Risk Guide (ICRG), provided
monthly to subscribers, mainly multinational investors. "Expropriation" is a subjective
indicator of the risk of confiscation and forced nationalization. "Repudiation of Contracts
by Governments" is a subjective indicator of the risk that governments will repudiate or
odterwise unilaterally change the terms of contracts with foreign businesses. Because these
two indicators provide similar information, in the regressions below an additive index of
them is used, labelled "Predictable Government"
Bureaucratic quality and corruption
Low quality bureaucracies are the second institutional dimension investigated below.
Bureaucratic organization and incentives are important components in their own right of the
institutional framework within which public investment decisions are made and
implemented. They are also indicative of the state of other institutions. The decisions of
bureaucrats are nearly always subject to the oversight of politicians. If politicians are
15
unconstrained in the demands that they can place on bureaucracies, or if they are subject to
frequent replacement, bureaucratic quality is likely to be lower.11 Directly or indirectly,
therefore, bureaucratic quality enters into the determination of the institutional parameter 9.
Two variables from the ICRG are relevant The first, "Quality of the
Bureaucracy", measures the degree to which the bureaucracy has the strength and expertise
to govern without drastic changes in policy or interruption of governmental services. Such
bureaucracies have established mechanisms for recruitment and training, and some
autonomy from political pressure. For the second variable, "Corruption in Government,"
low ratings are assigned to countries in which high government officials are likely to demand
special payments and where illegal payments are generally expected throughout lower levels
of government. Again, because the two variables offer similar information, they are grouped
in an additive index labelled "Bureaucratic Performance."12
Executive discretion and competitive elections
At the center of institutional arguments related to the insecurity of property rights is
the extent to which government hands are institutionally tied or not in questions of
expropriation. Underlying the security of property rights and the performance of the
bureaucracy is the structure of political institutions. The checks and balances arguments of
North and Weingast and others are precisely in this vein: when multiple government actors
must agree to expropriation or contract repudiation, the possibility of these actions being
undertaken is reduced.
Two indicators of executive discretion are used below. One, Executive
Constraints, indicates whether the executive in a country is subject to restraints on
unilateral decision making by other branches of government or parts of society (aggers, K
and T.R. Gurr 1995). The Database of Political Institutions (DPI), version 3 (Beck, et al.
2001) characterizes the presence of checks and balances with the variable Checks3. This
variable is built up from several other variables collected in the data set, induding the
number of parties in the government coalition (for parliamentary systems), whether the
president's party has a majority in the legislature (presidential systems), and whether elections
11 Noll and Fiorina (1978) is one of the first of a growing literature examining the interaction of political and
bureaucratic agents.
12 Resuits using either of the two components are very similar to results obtained from using the index. The
same is true for "Pretictable Govemment".
16
are governed by closed list or open list rules (the former granting more authority to the
heads of parties).
On the presumption that constitutional checks on executive behavior mean little if
the relevant actors are not elected, the construction of Checks3 also takes into account
legislative and executive indices of electoral competitiveness (EIEC and LTEC in DPI),
scaled one to seven.13 However, for completeness, we also consider the competitiveness of
elections separately. Where elections are more competitive, constraints on excessive rent-
seeking and expropriation by leaders are likely to be tighter.
Public investment data
The other key variable in the analysis below is public investment. To measure this
we follow Levine and Renelt (1992) and Devarajan, et al. (1996) by taking data on public
investment from the Government Financial Statistics (GFS) of the International Monetary Fund.
While GFS has some data on public investment by state and local governments, its most
complete and reliable coverage is of central government expenditures, not including
investments by state-owned enterprises.14
Property rights and the rate of public investment
Both models of property rights predict that, in the presence of rent-seeking that
takes the form of non-productive public investment, observed public investment ratios to
national income and private investment should be higher in countries that exhibit less secure
property rights. Table 1 focuses on the institutional model of property rights, and compares
13 Where there are no elections, countries receive a one; the scores rise to seven when there are multiple
candidates and multiple parties, and no single-party or candidate receives more than 75 percent of the vote. If
the legislative index of electoral competitiveness is less than five (where five indicates that multiple parties can
legally be established, but where only one party wins any seats in the legislature), checks is one. This reflects the
notion that legislatures that are not competitively elected are less likely to exercise decision making authority
independent of the executive. Otherwise, coding of this variable depends on whether countries are presidential
or parliamentary.
In presidential systems, checks is the sum of one (if EIEC is greater than four), one (for the
president), one for each legislative chamber, and one if the first government party is closer in political
orientation (eft, right or center) to the first opposition party than to the party of the president. If the legislature
is closed list (voters must vote for parties and cannot register candidate preferences) and the president's party
has a majority in parliament, the legislature is not counted as a check. In parliamentary systems, checks is the
sum of one (for the prime minister) and the number of parties in the governing coalition; the number of parties
is reduced by one if there is a closed list and the prime minister's party is in the coalition.
14 Barro (1991) appears to use the general government public investment, including decentralized government
expenditures from GFS where available. For a few dozen countries, Easterly and Rebelo (1993) supplement
GFS data on central govemment public investment with World Bank country reports that most notably include
data on investments by state-owned enterprise.
17
public investment across countries with different property rights and institutional
environments. The institutional/property rights variables are measured at the beginning of
the period to minimize endogeneity concerns.
Table 1: Average Public Investment to GDP (1974 - 98) Under Different Institutional
Arrangements
Range Mean values of Significance of
(see note) public difference in means
investment/GDP
(# of countries)
Bureaucratic (0 - 6.99) 5.9 (54) .0001
Performance (7 - 12) 3.5 (39)
Predictable (0 - 1.99) 6.0 (47) .0001
Government (12 - 20) 3.8 (46)
Executive (5 - 7) 5.8 (60) .0001
Constraints (see note) (1 - 4.99) 4.1 (45)
Checks3 (1) 6.3 (60) .003
(>1) 4.2 (54)
EIEC (1 - 2) 6.5 (31) .054
(3 - 7) 4.9 (83)
N.B. Higher values imnply better bureaucratic performance, more predictable govemment, more checks, more
competitive elections, but fewer executive constraints.
The first and second rows show that public investment as a share of GDP (averaged
over 1974-98) is signifcantly lower in countries that exhibit higher scores on the two
property rights variables, predictable government and bureaucratic performance.15
However, the institutional model of property rights fiurther suggests that specific political
institutions underlie the security of property rights. Again, public investment is higher in
countries that exhibit lower values for these institutional variables: executive constraints,
checks3 and the competitiveness of executive elections. Table 1, therefore, supports both the
predictions and the underlying institutional arguments of the institutional model of property
rights.
15 Tanzi and Davoodi (1997) make arguments about the effects of corruption on public investment which lead
them to consider the amount of public investment in corrupt and non-corrupt countries: they also find that
18
Table 2: Effect of institutions on public investment/GDP (1974-98)
(OLS, robust standW errors in parntheses)
Bureaucratic Predictable Checks3 Electoral
Performance Government Competitiveness
(EMEC)
Institutional -0.327 -0.201 -0.945 -0.754
Variable (0.155) (0.124) (0.267) (0.218)
Intercept 20.625 23.049 25.050 26.058
(6.677) (7.229) (6.849) (7.244)
Log initial -0.757 -0.924 -1.282 -1.250
income/capita (0.720) (0.767) (0.715) (0.790)
Area -0.190 -0.258 -0.306 -0.321
(0.202) (0.200) (0.229) (0.247)
Population -0.533 -0.499 -0.389 -0.420
(0.291) (0.314) (0.321) (0.366)
Secondary 0.022 0.014 0.013 -0.002
enrollment (0.028) (0.031) (0.028) (0.030)
Primary 0.045 0.047 0.043 0.058
enrollment (0.025) (0.026) (0.024) (0.021)
Initial price of -0.249 -0.234 0.018 0.024
investment goods (0.202) (0.197) (0.208) (0.213)
N 77 77 85 85
R2_ _ .45 .42 .43 .47
Table 2 examines the logic underlying Table 1, but controls for other variables that
might influence the government decision to supply public investment, including initial
income per capita, initial population and area, the initial price of investment goods in the
country relative to the US, and average human capital (educational achievement) over the
period. Public investment is consistently higher across all measures except for Exewtive
Constraints (not reported), for which the coefficient is of the right sign, but has a I-statistic of
only 1.08.
public investment is higher in corrupt countries.
19
Determinants of the ratio of public to private investment
Strictly speaking, the two property rights models, with rent-seeking, predict that
where property rights are more insecure, the ratio of public to private capital is higher. Data
on the stock of private capital is necessary to test these predictions directly, but is
unavailable. Instead, we use investment ratios, focusing as before on the threats to property
rights created by the potential of government expropriation.16
Table 3: Average Public to Private Investment Ratios (1974 - 98) Under Different
Institutional Arrangements
Range (see note) Mean values of Significance of
public/private difference in means
investment
(# of countries)
Bureaucratic (0 - 6.99) 27.0 (53) .0001
Performance (7 - 12) 15.5 (38)
Predictable (0- 11.99) 28.7 (46) .0001
Government (12 - 20) 15.5 (45)
Executive (5 - 7) 32.6 (54) .036
Constraints (see note) (1 - 4.99) 17.9 (44)
Checks3 (1) 34.5 (54) .0058
(>1) 18.0 (53)
EIEC (1 - 2) 40.1 (29) .002
(3-7) 21.2 (78)
N.B. Higher values imply better bureaucratic performance, more predictable government, more checks, more
competitive elections, but fewer executive constraints.
Table 3 shows the country means of the ratio of public to private investment under
different institutional arrangements. In all cases, the ratio in countries where institutional
scores are lower is significantly higher than in countries with higher institutional scores, as
the "institutional" model of property rights and public investment predicts.
16 At any given point in time, the stock of private capital is determined by the initial capital stock and the
change in capital stock over time, d/kdt, or koe4h/ As long as the rate of depreciation of capital is not too low
and the time period over which average rates of investment are compared is not too short, though, initial capital
stocks are likely to be small relative to capital stocks in most subsequent periods.
20
Table 4: Effect of institutions on public to private investment
(OLS, robmst standard emrs in parentheses)
Bureaucratic Predictable Checks3 Electoral
Performance Government Competitiveness
__________ ~~~~~~~~~~~~~~~(EIEC)
Institutional -1.229 -1.155 -5.058 -4.176
Variable (0.777) (0.610) (1.527) (1.806)
Intercept 74.305 81.880 153.76 159.836
(35.038) (33.905) (65.632) (65.309)
Log initial -0.797 -1.010 -5.651 -5.545
income/capita (4.455) (4.193) (4.574) (4.832)
Area -0.277 -0.624 1.576 1.465
(0.949) (0.961) (3.463) (3.314)
Population -2.176 -1.800 -4.251 -4.361
(1.232) (1.267) (4.028) (3.767)
Secondary 0.007 0.001 0.032 -0.034
enrollment (0.121) (0.122) (0.149) (0.156)
Primary 0.067 0.062 -0.289 -0.206
enrollment (0.110) (0.107) (0.340) (0.317)
Initial price of -1.049 -0.878 0.530 0.642
investment goods (0.889) (0.842) (1.187) (1.213)
N 76 76 83 83
R2 .34 .35 .19 .20
As with Table 1, the results in Table 3 might be sensitive to omitted variables and to
possible biases created by the use of private investment rather than the private capital stock.
Table 4 presents a more controlled comparison of the determinants of the ratio of public to
private investment across countries. The log of initial income per capita (from Summers
and Heston, 1991) is used, and can be interpreted as a proxy for initial capital stocks. In
addition, the regressions in the table include standard explanatory variables employed in
cross-country investment equations, including primary and secondary school enrollment
(averaged over the period), and the initial price level of investrnent goods relative to the U.S.
(from Summers and Heston, 1991).
21
Although the effects of these on the ratio of public to private investment is unclear,
education is expected to have a positive impact on private investment; investment goods
prices and initial income should have a negative influence. The population and area of a
country are also taken into account, as rough proxies of the demand for public goods and
economies of scale in infrastructure provision. Both might be expected to increase the
demand for public goods, although again their impact on the ratio of public to private
investment is unclear.
Table 4 reports results for predictable government, bureaucratic perfortnance,
Checks3 and the Executive Index of Electoral Competitiveness. The signs of each are as
predicted and statistically significant. The less secure are property rights and the less
constrained by political institutions are government decision makers, the higher is the ratio
of public to private investment. That is, even controlling fot a variety of other possible
influences on the ratio of public to private investment, this ratio is still higher in countries
with lower scores in the institutional indicators. Executive Constraints (not reported) is again
of the correct sign, but not quite significant at conventional levels, with a t-statistic of 1.54.
Rent-seeking, property rights and the quality of infrastructure
If the analysis in the paper is right, then we would expect the connection between
observed public investment and the quality of public infrastructure to be highest in countries
where property rights are secure - and where, therefore, incentives to extract high rents in
the form of "white elephants" would be lowest. To the extent that observed public
investment reflects rent-seeking, however, any relationship between spending and
infrastructure services would be weakened.
Table 5 presents some preliminary evidence on these issues. The dependent variable
is the change in quality of infrastructure over the 1900-2000 period, as measured by an index
constructed from four variables: population with access to an improved water source (in
percent); access to improved sanitation (in percent); electricity losses in distribution and
transmission (as a percentage of output); and kilometers of paved roads.17 Control variables
include initial (1990) infrastructure quality, growth in per capita income and population over
17 Changes over the decade are measured in percentage points for the first three variables; because paved roads
are measured in kilometers rather than percent, the percentage change is constructed by dividing the 1990-2000
difference by initial (1990) kilometers of paved roads. The infrastructure index is constructed by standardizing
each of the four variables to have mean 0 and standard deviation of 1, and taking the mean. The electricity
losses variable is reversed, so that greater losses are reflected in lower values of the index.
22
the decade, price level of investment goods (from Summers and Heston), and log of land
area (in square kilometers).
Table 5: Public Investment, Property Rights, and Improving
Infrastructure
(m bust standard e x rs in pamntheses)
Equation 1 2 3
Institutional Variable None Bureaucratic Executive
Performance consttaints
Public 0.015 0.014 0.028
Investment/GDP (0.016) (0.028) (0.016)
Institutional Variable -0.060 -0.025
(0.033) (0.026)
Public Investment* 0.014 0.014
Institutional (0.008) (0.008)
Variable
Initial infrastructure -0.146 -0.018 -0.006
quality (0.084) (0.090) (0.084)
Per capita income -0.230 -1.735 -0.454
growth 1990-98 (1.562) (1.652) (1.581)
Population growth 11.085 7.699 9.607
1990-98 (3.972) (4.336) (4.058)
Price level of 0.002 0.002 -0.002
investment goods, (0.003) (0.004) (0.001)
1990-98 mean
Log of land area 0.033 0.041 0.050
(0.021) (0.026) (0.024)
Constant -0.708 -0.320 -0.543
(0.466) (0.548) (0.396)
N 89 76 84
R2 .17 .28 .31
Equation 1 in the table shows the weak overall relationship between public
investrnent over the decade and improvement in infrastructure. The coefficient on initial
quality is significant at the .10 level, and negative as expected. The strongest predictor is
population growth. Equation 2 adds burraucraicpeformance and its interaction with public
investment. The coefficient on the interaction term is positive (and significant at the .10
23
level), indicating that public investment expenditure produces larger improvements in
infrastructure where bureaucratic quality is lower and corruption is higher. This coefficient
implies that the impact of public investment varies from a low of -.043 (with a standard error
of .029) conditional on a bwreameamticpeformance value of 3 to a high of .079 (with a standard
error of.06) when bsuraucraticpec*rmance is 12.
Equation 3 uses an alternative measure of constraints on last period political decision
makers to expropriate, executive constraints, which varies from a minimum value of one to a
maximum of seven. Results are very similar, as the interaction term has a positive
coefficient, significant at the .08 level. The impact of public investment on infrastructure,
conditional on the minimum executive constraints value of one, is -.024 (a standard error of
.025). Conditional on the maximum value of 7 - which characterizes 24 of the 84 countries
in the sample - the marginal effect of public investment on infrastructure is .062 (a standard
error of .031). In fact, spending is significantly associated with infrastructure improvement
as well conditional on any executive constraints values of 5 or more.18 Interactions are not
significant, however, usingpredictablegovernment, checks3 and the executive index of electoral
competitiveness (EIEC).
Public investment and growth
Conflicting or inconclusive results permeate the existing, extensive empirical
literature on government spending in general and public investment in particular. Barro
(1991), De Long and Summners (1991), Levine and Renelt (1992) and Landau (1983) report
that public investrnent has an insignificant impact on growth. Easterly and Rebelo (1993),
on the other hand, conclude that some types of public investment (transport and
communication) have a positive correlation with growth, as does government investrnent in
general. Devarajan et al. (1996) show that the substitution of government investment for
other types of government expenditures has a negative impact on growth, however.
The foregoing analysis suggests that the neglect of property rights and rent-seeking
considerations in this literature may have influenced its findings. When property rights are
insecure, observed public investment is more likely to consist of rent-seeking, and therefore
be unproductive. High levels of observed public investment due to rent-seeking, which
would be associated with lower levels of growth (ower, because the taxes that finance higher
18 At 5, the coefficient is .033 and the standard error is .017; at 6, the coefficient is .048 and the standard error
24
rent-seeking suppress growth), are therefore conflated with high levels of productive public
investment with potentially positive growth effects. This problem would not emerge if one
could easily distinguish productive and non-productive public investment, but the data do
not permit this. We test whether the property rights/rent-seeking nexus identified above in
fact obscures the growth effect of productive public investment. We do this by including
the interaction term (public investment x institutional variable) in the standard empirical
growth equation that has been used in the past to examine the effects of public investment
The control variables used are the school enrollment and initial income per capita
variables from Tables 2 and 3, and private investment/GDP averaged over the period.
Initial income is included to account for any "catch-up" effect that might exist, including the
effect of initial capital stock.19 Changes in human capital are proxied by primary and
secondary school enrollment. The growth effect of public investment is determined in the
model jointly with incentives to undertake private investments, so private investment over
GDP is included. Any growth specification is vulnerable to the claim that omitted variables
account for observed relationships; to mitigate this problem, we follow common practice in
including continent dummies in the base specification to capture omitted effects that have
continent-wide effects. We also control for inflation. To the extent that governments
finance public investment through unsustainable mechanisms, such as money creation, it is
less likely to have positive growth effects. Inflation is a better measure of unsustainable
financing than tax revenue or deficit measures, since the efficiency with which governments
can collect taxes and the extent to which money demand is sensitive to government deficits
vary widely.
Table 6 displays the core results. Equation 1 is the base specification and includes
no institutional variables or interactions. Consistent with Devarajan et al. (1993), the
coefficient on public investment is negative and (marginally) significant. Other significant
variables include inflation, initial income, and the Africa dummy (the OECD is the omitted
category).
is .024.
19 However, see Keefer and Knack (1997) for institutional detemiinants of the strength of this effect.
25
Table 6: Public Investment, Property Rights, and Growth
(robust standard errors in parentbeses)
|Equation l 2 3
Institutional Variable None Bureaucratic Predictable
l ~~~~~~~~~~~Perforrnance Government
Pulc Investrnent/GDP -0.112 -0.054 -0.021
(0.057) (0.087) (0.075)
Institutional Variable 0.085 -0.054
(0.100) (0.110)
Public Investment* 0.013 0.042
Institutional Variable (0.017) (0.020)
Log of initial per capita -0.679 -0.853 -0.547
GDP (0.350) (0.436) (0.369)
Secondary enrollment 0.002 0.002 0.007
(0.017) (0.019) (0.016)
Primary enrollment 0.015 0.015 0.016
(0.010) (0.011) (0.010)
Private Investment/GDP, 0.058 0.053 0.044
Mean 1974-89 (0.049) (0.049) (0.049)
Latin America & -0.780 -0.679 -1.322
Caribbean (0.890) (0.829) (1.055)
Sub-Saharan Africa -3.186 -3.280 -3.593
(1.133) (1.130) (1.243)
East Asia& Pacific 1.371 1.231 1.062
(1.078) (1.098) (1.143)
Middle East & North -0.572 -0.424 -0.638
Africa (0.902) (0.897) (1.103)
Eastern Europe and -1.287 -1.207 -1.724
Central Asia (1.328) (1.437) (1.403)
South Asia 0.235 0.146 -0.166
(1.053) (0.981) (1.124)
Inflation Mean (log) -0.524 -0.488 -0.563
(0.202) (0.209) (0.188)
Constant 7.005 7.566 6.625
(3.144) (3.491) (3.067)
R2 .55 .56 .58
Note: Sample size is 80. Mean of dependent variable is 1.09.
26
Equations 2 and 3 display results for the two property rights variables, Bureaucratic
Petformance and Predictabk Government, and their interactions with public investment20 As the
"institutional" model of public investment and property rights predicts, the interaction term
in equation 3, with Predictable Gouernment, is positive and statistically significant. This is the
variable that most precisely relates to the threat of government expropriation. Although
positive, the interaction in equation 2, Bureaucratic Perfojrance, less directly related to
government expropriation, is not significant. Whenpredictablegovernment equals its sample
mean (12.4 on the 20-point scale), the net effect of public investment on growth is near zero
(-.021). Whenpredictablegovernmentis equal to 10 or less (as it is for 28 of the 80 countries in
the sample), a one percentage point increase in public investment has a significant negative
association with growth. Whenpredictabklgovernment is at its maximum level, a one
percentage-point increase in public investment as a share of GDP increases growth by nearly
0.3 percentage points.21
Conclusion
The analysis in this paper exposes and explains an important effect of insecure
property rights that has not been previously noted: insecure property rights not only drive
down private investment; they also distort important public policy decisions of government.
We document significant variation in public investment across countries with secure and
insecure property rights, showing that observed public investment as a fraction of national
income or private investment is far higher in the latter than the former. The intuitive
explanation for this finding is not correct: governments do not have an incentive to invest
more in productive public investment in order to offset the negative effects of insecure
property rights on private investmrient. On the contrary, we show that productive public
investment is, at best, unaffected by insecure property rights (when insecure property rights
are due to the threat of government expropriation), and at worst is significantly reduced,
when property rights are a law and order problem that can be remedied by government
spending.
20 Interactions are computed as the product of the deviations of public investment and the institutional
variables from the ir sample means. Thus, the coefficient on public investment in equations 2 and 3 indicates
the effect of a 1 percentage-point increase in that variable conditional on the institutional variable being equal
to its mean value.
21 Only Luxembourg scores a perfect 20, however, followed by Switzerland (19.6), Netherlands (19), and the
U.S. and U.K (18.8). Most developed nations score above 17. Therefore, the effect is significant at the .076
27
Instead, we show that insecure property rights increase government rent-seeking.
Rent-seeking governments are willing to accept lower rents in the current period if the
correspondingly lower tax rate triggers higher private investment and a correspondingly
larger stream of future rents. Insecure property rights reduce the future stream of rents and
therefore encourage rent-seeking. We show that the effect of insecure property rights on
rent-seeking can be dramatic, and indeed is likely to be substantially greater than any
reduction in productive public investment. At the same time, we note that observed public
investmnent in many countries is associated with rent-seeking activity, thereby suggesting a
solution to the puzzle with which we begin the paper. Significantly higher observed public
investment in countries with insecure property rights - and the scant or negative effect of
that investment on economic growth - is in fact a reflection of the enhanced rent-seeking
incentives of governments in environments where property rights are more insecure.
The results of this analysis go beyond the usual arguments underlining the
importance of institutional issues in economic growth. For example, development policy
often focuses on a two-pronged approach that emphasizes both non-distortionary and
investment-friendly tax policies, but also secure property rights and protection of investors
against unexpected expropriatory activities. The analysis here suggests that these two prongs
are not independent: the very insecurity of property rights induces governments to distort
fiscal policy in growth-suppressing ways. The results therefore draw attention to the
complementarity of institutional quality and policy effectiveness and are likely generalizable
to other policy settings: the success of policy interventions generally, like the effectiveness
of public investment in boosting growth, is likely to depend on the institutional environment
in which those policy changes are made.
level for a one-tailed test.
28
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Policy Research Working Paper Series
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WPS2896 The Wage Labor Market and John Luke Gallup September 2002 E. Khine
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